Homepage / Investment / Defense stocks soar on the spectre of war with North Korea
States are so eager to win Amazon's HQ2 they're offering the company as much as $7 billion A new bill would require Facebook and Google to publicly archive ads purchased around elections A scientific breakthrough offers hope for an AIDS vaccine One of the hottest smart home start-ups in Silicon Valley was just acquired A new Tencent game lets users virtually clap for a leader of the Chinese communist party Verizon meets earnings expectations and beats Wall Street's forecast for revenue Elon Musk says his second tunnel digging machine for The Boring Company is 'almost ready' Private jets are getting cheaper Cryptocurrencies like bitcoin are not 'mature' enough to regulate, ECB chief Mario Draghi says Companies that burn up $1bn a year are sexy, dangerous, and statistically doomed Viral Chinese video game measures which players can clap fastest for President Xi Jinping On NAFTA, America, Canada and Mexico are miles apart Spain to suspend Catalonia's autonomy after regional leader fails to drop independence bid Bitcoin is not the new gold, Goldman Sachs says New Zealand Labour to form next government with support of small nationalist party Here are the best cities to claim your pension — but all fall short of a relaxing retirement Unilever blames poor weather for slowing growth Want to learn about fintech? There's a course for that Backroom battle imperils $230 million cryptocurrency venture LSE CEO Rolet to step down by end of 2018 Roche third-quarter sales beat forecasts with boost from new multiple sclerosis medicine London is the European hotspot for venture capitalists when it comes to fintech SAP third-quarter growth slows with dip in cloud subscriptions Europe set for mixed open as investors look to earnings, Catalonia deadline China's central bank is warning about a sudden collapse in asset prices China's central bank governor says he's likely to retire soon This ex-Googler is bringing self-driving excavators to construction sites India's high-flying start-ups are getting a dose of harsh reality Here comes Chinese GDP data at a pivotal time for the country MongoDB will raise $192 million in IPO, making it worth $1.2 billion Asia markets await China data after Dow closes above 23,000 for the first time Blue Apron layoffs hit office hardest, warehouse workers mostly spared, say sources Lawmakers urge US to craft targeted sanctions on Myanmar military Cramer Remix: Johnson & Johnson is out of battleground territory Cramer: Facebook's latest acquisition is a 'terrific insurance bet' against Snap Firm says it was wrong about Snap and slashes key estimate in half — but still no 'sell' rating IBM will get a strong tailwind from the weak dollar, CFO Martin Schroeter says Cramer sees great buying opportunities in 'Washington's shenanigans' Bids for Amazon's second headquarters are due Thursday – here are all the cities in the running Blue Apron cuts 6 percent of its workforce Amazon is spreading itself thin and getting into the ‘danger zone,’ analyst says Adobe shares jump more than 5 percent on 2018 profit forecast Snap's newest product is a 'dancing hot dog' costume Wall Street veterans are trickling into digital asset management State pension funds continue to fall behind. Here's how much you owe Senators are pushing to curb election meddling on social media Here are 4 top chip stock ideas for the next year: Barclays Russians used Facebook Messenger to interfere with election, top executive says Samsung is playing catch-up with Apple's Siri and the Google Assistant The federal lawmakers who regulate Amazon are begging the company to move to their home states Warren Buffett just made nearly $800 million in IBM, a stock he doesn’t even like that much The 2017 chart of the stock market looks 'eerily similar' to the one that crashed 30 years ago Google's AI subsidiary made a game-playing program that's entirely self-taught Xi sees US retreating on world stage and seeks to fill void as 'most powerful' Chinese leader in 45 years Tech companies are suddenly spending much more on lobbying as NAFTA negotiations loom Shares of IBM just did something they haven’t done in 15 years 'It's very hard not to give tax cuts to the wealthy,' Steven Mnuchin now says Bond market flashing warning sign even as stocks rally to new highs Mohawk Tribe sues Microsoft, Amazon for patent infringement Bitcoin plunges nearly 9% on fears of greater oversight from US regulators US 10-year yield flashes possible warning: Dallas Fed's Kaplan Chinese fintech company Qudian spikes more than 40 percent in IPO 'The housing market can't take the shock of a natural event,' real estate economist warns The Apple Watch is finally taking off, says analyst By selling now, investors risk missing an additional 'melt-up' in the market Amazon's next big bet is letting you communicate without a smartphone, says Alexa's chief scientist Cramer: IBM is not a Warren Buffett story anymore but about 'reignition of earnings' IBM sees biggest jump in 8 years after earnings beat Rising seas threaten nearly $1 trillion worth of US homes, says Zillow Germany's Hochtief confirms $20 billion bid for Spain's Abertis Amazon's $13.7 billion bet on online grocery ordering hasn't convinced shoppers to stay home The same federal lawmakers who regulate Amazon are wooing the company in the race for HQ2 OPEC reportedly favors 9-month extension to output cut deal in bid to boost oil prices Stephen Curry’s new shoe will spark an Under Armour turnaround: Analyst Apple and GE are writing software to help detect when jet engines could fail Merck shares jump after Citi upgrade on stronger cancer drug sales US investors should get some international exposure Elon Musk is 'fixated on Mars' but Bezos and I want space to better Earth, says Richard Branson Hurricanes Harvey and Irma drive housing starts down to a one-year low When the revolution eats itself Stocks making the biggest moves premarket: CVX, MGM, ANTM, IBM, CREE, AMZN & more Hillary Clinton says US threats of war with North Korea are 'dangerous' and 'short-sighted' Twitter’s new user rules crack down on nudity and 'unwanted sexual advances' The only thing scary about the Dow is that nothing seems to scare it Economist lays out a ‘concerning’ trend for Apple stock 1 billion users could be using 5G by 2023 with China set to dominate, study says The big question for US cities: Is Amazon’s HQ2 worth the price? Google and Goldman Sachs are two of the most active investors in blockchain firms Iraq calls on BP to 'quickly' develop disputed oilfields after seizing areas of Kirkuk Amazon, eBay accused of ‘profiting’ from tax fraud in UK JPMorgan buys fintech start-up WePay WhatsApp is blocked in China and VPNs are being hit as the Communist Party Congress begins Xi Jinping makes big promises for China's economic future Akzo Nobel issues profit warning after third-quarter earnings miss Boeing says Bombardier jets could still face hefty duties even if they are assembled in Alabama European shares expected to open on a positive note as earnings season picks up the pace InterContinental is bringing two new hotel brands to Asia India's troubled banks desperately need more money — but government help just isn't coming An upcoming fintech IPO is set to be 2017's largest Chinese listing in the US Amazon has brought benefits—and disruption—to Seattle

Investment

Defense stocks soar on the spectre of war with North Korea

On Oct. 1, President Donald Trump once again took to Twitter to attack Kim Jong-un, saying that negotiating with the North Korean chairman is a waste of time. While social media mudslinging may not be the best way to deal with a hostile leader, there’s at least one group who may not mind Trump’s Twitter threats: defense industry investors.

Year-to-date, the S&P 500 Aerospace and Defense Industry subsector index is up 30 percent, compared to 12.9 percent for the S&P 500. Since July 3, when North Korea fired its first intercontinental ballistic missile and Trump said in a tweet, “Does this guy have anything better to do with his life?” the index has climbed by 14.3 percent.

While most people likely don’t want to go to war with North Korea, the increasingly heated rhetoric is helping many defense-industry stocks reach record highs.

“The more people that are nervous and afraid of what’s going to happen in the world, the more it drives multiples higher,” says David Chung, a research analyst at Janus Henderson Investors. “What we’ve seen in the last month with North Korea elevates that uncertainty.”

As high as these stocks have climbed, some investment professionals, including Chung, still think there are opportunities to be had, though it will be increased defense-sector spending, not Twitter tirades, that drives the industry forward.

Typically, it’s the promise of increased military spending that boosts defense-sector stocks, says Karen Hiatt, a senior portfolio manager with Allianz Global Investors. While the sector has been outperforming the broader index for a few years now, prices jumped 6.8 percent in the week after Trump was elected, and they’ve climbed another 31 percent since then.

The increase is partly due to the Republican Party being seen as more military friendly, but Trump also said in February that he wanted to increase military spending by $54 billion. On Sept. 18 the Senate passed a $700 billion defense policy bill that exceeds Trump’s original request. That’s good news for investors, especially if those increases continue.

“There’s a very high correlation between government spending around defense,” says Hiatt.

However, it’s often not about the actual increase that drives stocks higher, but the expectation for change, she says. It was in 2013, when defense spending bottomed, that these stocks really started to rise. This year’s gains occurred because of the potential for increased spending — the subsector has risen only by 3.95 percent since the September announcement, though that’s still better than the 1.9 percent for the S&P 500.

More from Global Investing Hot Spots:
Why the gusher in European stocks should continue
China’s real estate investors are now on a $200B buying spree

For Dan Gruemmer, a portfolio manager with American Century Investments, those expectations — of increased spending and a more defense-friendly president and Congress —have not only helped push stocks, like Lockheed Martin and Harris Corp. higher, but they’ve created inflated valuations, too.

“We’re in an environment right now where sentiment has been playing a larger role,” he says. “And now they’re almost priced to perfection.”

Indeed, valuations are high, with many stocks having price-to-earnings ratios above 20. Both Lockheed Martin and Northrop Grumman — the latter purchased missiles and satellite maker ATK Orbital for $9.2 billion in September — are trading at 23 times forward PE, the highest their PEs have been in years, according to S&P Capital IQ. Gruemmer, who uses an intrinsic value metric in his company assessments, says that most defense companies are trading at least 10 percent higher than where they should be.

While Chung agrees that valuations are elevated, most industrial stocks, which is the industry defense falls under, are trading at similar levels. He’s still bullish, though, because over the last few years, these companies have become better operators.

Since the 2013 spending bottom, most have reduced costs and increased margins. Boeing, which is more known for its airplanes but does have a robust defense business, has cut $5 billion of costs over the last four years, while defense-segment operating margins have improved from 9.4 percent to 11.5 percent, says Chung. It’s a similar story with other companies. All the sector needs now is to increase volume.

“They’ve done a lot of great things on the cost side, and production processes are in a much better place,” says Chung. “Imagine what will happen if they get more volume through that.”

Some companies also have certain divisions that have yet to see a growth increase. For instance, General Dynamics’ combat systems business is “down meaningfully from its peak,” says Chung, while Harris’ radio communications division is down 50 percent from where it once was. He thinks both will rebound because of increasing order activity and higher budgeted amounts for those categories in the defense budget.

“Some stocks have certain programs that have been depressed over the last five years —incremental margins have come down 30 percent to 50 percent off of the peak,” he says. “We think the profitability profile is quite attractive.”

Hiatt likes the sector’s fundamentals, too. Many of the companies have strong free cash flows and attractive yields, she says. Lockheed Martin, a company that she likes, has a 4.5 percent free cash flow yield, returns on capital of more than 20 percent and a 2.58 percent payout.

As well, because defense spending is determined in advance, earnings growth tends to be more predictable than in other industrial sectors, she says.

Another potential boost could come from international sales, which is a higher-margin business, as companies tend to charge other governments more to buy their equipment, says Gruemmer.

While America will always be the biggest buyer of military equipment, if the spectre of war increases in the Korean Peninsula, the Middle East and elsewhere, other countries could beef up their militaries as well. In September, President Trump announced his administration will permit U.S. allies Japan and South Korea to purchase a higher-than-expected amount of high-tech military equipment as the countries move to contain North Korea.

“Any time you see increased conflict in certain regions of the world, you often see increased international sales,” he says. “And typically, companies realize higher profits with foreign customers.”

When it comes to buying into the sector, if you believe that the entire industry will continue to climb — and Chung does think the sector overall will continue to outperform — then you can purchase an exchange-traded fund, like the iShares U.S. Aerospace and Defense ETF (ITA), which is the largest defense-sector ETF, with $4.5 billion in net assets.

The fund, which is up nearly 29 percent this year, holds U.S. operations that manufacture commercial and military defense equipment — all of the large-cap defense stocks, like Boeing, United Technologies and Lockheed Martin, are in the portfolio. For mutual fund buyers, Fidelity Select Defense and Aerospace fund, which also holds the brand-name defense companies such as Boeing, Northrop, Raytheon and Rockwell Collins, among others, is a popular choice. It’s rated four stars by Morningstar and is up 28 percent year-to-date.

Those who want to make a bet on an individual stock, though, should look for companies with attractive cash-flow yields, product-line diversity and wide geographic exposure, says Hiatt. Companies with low leverage and an ability to return money to shareholders through dividends or buybacks is important, too, adds Chung.

He likes General Dynamics, Harris and Northrop Grumman, partly because they have strong CEOs, good cash-flow yields and certain divisions, like radios for Harris and unmanned aircraft for Northrop, which should experience strong growth over the next several years.

No matter what you buy, though, the prospect of conflict and increasing military budgets worldwide should continue to push these stocks even higher.

“The world isn’t getting safer, and there’s a need for these companies’ services,” says Chung. “We feel comfortable about their competitive advantages, and their moats are wide. That’s a good backdrop.”

— By Bryan Borzykowski, special to CNBC.com

Source: Investment Cnbc
Defense stocks soar on the spectre of war with North Korea

Comments are closed.